As a business owner, entertaining and dining with clients, vendors and potential employees is often a successful strategy for building strong business relationships. While these expenses are essential for your business to run smoothly, the related tax benefits may be long gone thanks to tax reform.
By now, every business owner should be aware of the once-in-a-generation tax law changes implemented by the passage of the Tax Cuts and Jobs Act (TCJA) at the end of 2017. But are you fully aware of how these changes apply to your meals and entertainment (M&E) expenses?
To provide further clarification, the Internal Revenue Service (IRS) officially issued proposed regulations for meal and entertainment expense deductions in late February 2020. The proposed regulations may significantly impact how you pay or incur M&E expenses. Now is the time to make yourself aware of the proposed regulations and start strategizing for the future.
How did the TCJA change meal and entertainment deductions?
Under prior law, the Internal Revenue Code (IRC) stated that you could generally deduct 50% of meals and entertainment expenses. Broadly defined, meals are food or beverages, and entertainment is “any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement or recreation, or with respect to a facility used in connection with such activity.”
These definitions were intentionally broad, and numerous exceptions existed to allow complete, 100% deductibility of certain meals and entertainment expenses.
However, the 2017 TCJA enacted the most substantial overhaul of the US tax code in decades and sought to further limit the deductibility of some meals and most entertainment expenses (but with some important exceptions still intact).
The deductibility of many popular employer-provided fringe benefits, such as deductions for work-related activities—including certain meal and entertainment expenses – have undergone sweeping changes.
Now more than ever, as an employer you need to understand your M&E expenses and ensure they are properly categorized and deducted, to avoid lost tax savings.
Prior to the TCJA, Sec. 274(a) allowed taxpayers to deduct 50% of “entertainment, amusement, or recreation” expenses, when the taxpayer established “that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion…, [or] such that item was associated with, the active conduct of the taxpayer’s trade or business.” However, after the TCJA, the wording appeared quite different. More specifically, the TCJA vanquished the “directly related or associated with” tests presented in Sec. 274(a).
As a result of the change in Sec. 274(a), the TCJA effectively and completely eliminated the employer tax deduction for substantially all directly paid or reimbursed business entertainment expenses. In the meantime, it allowed employers to deduct certain enumerated expenses listed as exceptions in Sec. 274(e).
Generally, Sec. 274(e) provides guidance for recreational, social or similar activities (including facilities) expenses primarily for the benefit of employees. Interestingly, the exceptions under sections 274(e)(5) and (e)(6) (regarding employee, stockholder and business league meetings) are now regarded as entertainment expenses due to the rewording of Sec. 274(a) under the TCJA.
In summation – and more simply – as a result of tax reform, typical business entertainment is 100% nondeductible for expenses paid or incurred after Dec. 31, 2017. No more deductions for taking a client to a sporting event, concert, or resort.
Most importantly, business meal expenses remain deductible, but with some adjustments to deductibility amounts. Also, the TCJA repealed the exception that provided a full 100% deduction for food and beverage excludable from employee income as a de minimis fringe benefit under Sec. 132(e). Generally, these costs are not subject to the 50% limit on deducting meals.
Despite changes to the de minimis fringe benefit exception, taxpayers may deduct 50% of an otherwise allowable business meal expense. However, there are new guidelines that determine the meaning of “allowable business expense.”
These guidelines include:
- The meal costs must be “ordinary and necessary” business expenses
- The costs may not be “lavish or extravagant”
- An employee of your company must be present at the meal
- If the meal is at an entertainment event, the meal must be separately priced.
After the changes implemented by the TCJA, many taxpayers were unsure about the deductibility of different business meal expenses. They looked to the IRS and other regulatory bodies for clarification.
What happens to meal expenses incurred during entertainment activities?
With the changes came confusion. Uncertainty emerged in regards to whether meals provided during an entertainment event fell under the meal or entertainment deduction limit (for example, a meal in connection with a business client at a ballgame).
In October 2018, the IRS released an advance version of Notice 2018-78 as transitional guidance on the deductibility of expenses for certain business meals under Sec. 274.
The Notice explained that while the TCJA did not address the circumstances when the provision of food and beverages might constitute entertainment, the legislative history clarifies that taxpayers may continue to deduct 50% of the food and beverage expenses associated with operating a trade or business.
In addition, the Notice acknowledged that future proposed regulations would clarify when business meal expenses are nondeductible expenses and when they are 50% deductible expenses.
This brings us to the latest proposed regulations issued in February 2020.
What are the latest proposed regulations?
The IRS officially announced their proposed regulations on February 24, 2020 to: 1) address the elimination of entertainment, amusement or recreation activities expense deductions, and 2) offer guidance on how to determine whether an activity qualifies as entertainment.
Furthermore, the proposed rules also deal with the limitation of food and beverage expense deductions.
Today, the proposed regulations generally align with Notice 2018-76 while introducing a few changes or clarifications.
Within the proposed regulations, the IRS clarifies that taxpayers may generally continue to deduct 50% of the food and beverage expenses associated with operating a trade or business, despite changes to the meal and entertainment expense deduction under Sec. 274.
Under the proposed rules, taxpayers may deduct 50% of an otherwise allowable business meal expense if they satisfy the following criteria:
- The expense is an ordinary and necessary business expense under Sec. 162(a) paid or incurred during the tax year when carrying on a trade or business;
- The expense is not lavish or extravagant under the circumstances;
- The taxpayer or an employer of the taxpayer is present when the food and beverages are furnished;
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
- For food and beverages provided during or at an entertainment activity, they are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.
How can Squar Milner help?
Even two years removed from the institution of tax law changes by the TCJA, confusion remains. Between issued Notices and proposed regulations, understanding what the law is at any given time is anything but easy. But the good news is that you do not have to try to figure it out on your own.
Our tax team at Squar Milner remains diligently up-to-date on the latest changes and is ready to help you and your business come up with the best tax strategies. We can work with you to ensure we are staying compliant with the law while concurrently maximizing your tax savings.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.